Bank of England hikes interest rates again as it struggles to tame inflation

The Bank of England’s (BoE) monetary policy committee (MPC) raised interest rates by a further 0.25% to 4.25% at its meeting on 23 March 2023, meeting consensus expectations. This was down from the 0.50% increase at its previous meeting, when it said that a further deterioration in the inflation outlook would be needed to raise rates further. However, since then the collapse of Silicon Valley Bank and the forced bail-out of Credit Suisse have led to concerns about the global banking sector. Yet, these risks appear not to have swayed the committee.

Minutes showed that its sister financial policy committee (FPC) had concluded that the UK banking system “remained resilient” and that it “was well placed to continue supporting the economy in a wide range of economic scenarios”. But with bank wholesale funding costs having risen globally, the MPC pledged that it would “continue to monitor closely any effects on the credit conditions faced by households and businesses”.

Inflation remains the monetary policy committee’s main concern

For the time being, inflation remains the committee’s main concern. Food and core goods inflation have both proven significantly stronger than the BoE had projected. But the latter had been largely due to higher clothing and footwear prices, which the MPC noted had tended to be volatile. However, at the same time, the persistent tightness of the labour market has led the committee to now expect the unemployment rate to be flat in the coming months rather than rise.

Most of the MPC therefore considered that the recent strength in domestic demand could be being driven by factors “over and above” falling energy prices, noting that the recent strengthening had partly preceded the falls in prices, and that renewed and sustained labour demand could further entrench the currently high rate of inflation. Conversely, the two members who voted to leave rates unchanged placed greater weight on the assumption that prior sizeable rate increases were yet to filter through to the wider economy due to delays associated with monetary policy.

Further hikes could lead to a sharper fall in housing prices

Looking ahead, the lack of consistency in the BoE’s communication is troubling. Markets are pricing in another 0.25% rate rise in June 2023. While further rate rises would help bring the UK’s inflation rate back towards target faster, it also increases the risk of a sharper fall in housing prices. The UK gilt market could also come under pressure as the UK government is borrowing more than most other advanced economies, just as the BoE is selling the stock of its gilts holdings back to the market.

However, based on the messaging presented, our expectation is that there is at least one further rate hike left to come. Once again, the MPC stated that if there was evidence of more persistent inflationary pressures, then further policy tightening was likely to be required. Given that the labour market looks set to remain resilient in the coming months, we expect the MPC to sanction another 0.25% hike in May 2023, with any further rate rises conditional on domestic and global developments.